ECON2915 Economic GrowthLecture 10 : Specific Factors.

Andreas Moxnes

University of Oslo

Fall 2016

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Introduction

Recall, in Ricardian model:Two products (e.g. rice and cocoa) and one input (labor).Trade occurs because of relative productivity differences acrosscountries −→ comparative advantage.

In this and the next lecture, we will extend the model to allow forMany inputs (e.g. labor & capital, or skilled & unskilled labor).Enables us to analyze who gains/loses from trade.Some groups may lose even if trade gives GDP growth in theaggregate.

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Specific factors model

Specific factors model:Two products and two inputs (e.g. labor and capital).One or both of the inputs cannot move across sectors.

I Both: Pure specific factors model.I One: Mixed specific factors model (Ricardo-Viner model).

How can factors be specific to the industry?Short-run focus.Barriers to mobility (geographic, technological, regulatory..).

We’ll focus on the long run next week: The Hecksher-Ohlin model.

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Case study

Case study: 1828 US tariff bill.US industrial structure in early 1800s:

North: Early manufacturing, e.g. cotton textilesSouth: Food, cotton, tobacco.

Rapid manufacturing growth in the North because:Tariffs.War-related interruptions in imports (including embargo of 1807-8).

Growth heavily concentrated in New England.

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A New England textile mill, 1819

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Protectionism in the North

Rising industrial sector in New England led to an interest groupseeking protection from imports.First tariffs: 1789: 5% ad valorem tariff on most imports.Several increases in tariff: 1816, 1820, 1824, 1828. 1816: 25% advalorem tariff on cotton textiles.

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How about the South?

South generally opposed import tariffs.Economy was based on export crops; no manufacturing to speak of.Constitutional convention: 1787: Southern delegates wanted a ban onimport tariffs and export taxes.

I Settled for ban on export taxes.

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Tariff bill of 1828

Unprecedented high tariffs.Average above 50%.North voted for.South vote against. West voted for.Southern politicians denounced the bill as an ‘abomination.’

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Average US tariffs 1790-1836

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The economics

Clearly a comparative-advantage economy.Exports of cotton and tobacco.Imports of manufactures (such as textiles and apparel).But in a Ricardian-type economy there’d be no conflict over tradepolicy.Conflict can be understood as a result of specific factors.

I Specific factors in North (manufacturing) gain from tariff.I Specific factors in South (agriculture) loses from tariff.

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A pure specific-factors model

Two goods:I Cotton textiles (aka cloth, C ). Produced in North.I Tobacco, T . Produced in South.

Cotton textiles requires L and K .Tobacco requires L and A (acres of land).Capital and manufacturing labor are specific to C ;Land and agricultural labor are specific to T .Assume that cotton textiles are imported, tobacco exported.

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Equilibrium

North: LN workers, KN units of capital.Perfect competition, so nominal wages equal to the value of themarginal product of labor:

wC = pCMPLC(LC/K

).

−→ factor prices will adjust so that demand for labor and capitalequals (the fixed) supply.Similar for the price of capital services:

rC = pCMPKC(LC/K

).

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The impact of a tariff : North

Assume that the US market is relatively small, so that pC and pT aredetermined on world markets.Then a 50% tariff on C will increase pC by 50%.Both wC and rC increase by 50% when pC increases by 50%.Therefore, both workers and capitalists in the North benefit from thetariff.

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The impact of a tariff : South

In South, the following must hold:

wT = pTMPLT(LT/A

)rT = pTMPKT

(LT/A

)Neither wT and rT increases because of the tariff, since pT isunchanged.Why is pT unchanged?Therefore, Southern factors’ nominal incomes are unchanged, even asthe price of cloth goes up.Real incomes of owners of Southern factors fall due to the tariff.

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An unrealistic feature of the model

When tariff goes up, what happens to the allocation of labor to thecloth industry?

Nothing.Therefore, what happens to output in the cloth industry?Nothing.

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An unrealistic feature of the model

When tariff goes up, what happens to the allocation of labor to thecloth industry?Nothing.Therefore, what happens to output in the cloth industry?

Nothing.

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An unrealistic feature of the model

When tariff goes up, what happens to the allocation of labor to thecloth industry?Nothing.Therefore, what happens to output in the cloth industry?Nothing.

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The Ricardo-Viner model

Assume labor mobile, capital/land fixed.I We must have a single wage w for the whole country.I rC and rT still different.

Equilibrium: Cloth manufacturers will hire until:

pCMPLC(LC/K

)= w

Tobacco growers will hire until:

pTMPLT(LT/A

)= w

At the common value of the wage, labor demand from both sectorsmust sum to the total supply, L= LC +LT .3 equations and 3 unknowns (w , LC and LT ).

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Equilibrium

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Capital income

Area under pCMPLC curve equals pCQC .Subtract wage bill, wLC , to get income to Northern capitalists. 18 / 34

Effect of the tariff

Shifts the pCMPLC curve up everywhere proportionally (by 50%).Wage w goes up.LC goes up, LT goes down. Output QC goes up, QT goes down.

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Winners and losers

Cloths: Workers & capitalists gain nominally.Tobacco: Workers gain, land owners lose, nominally.

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Winners and losers

Cloths: Workers & capitalists gain nominally.Tobacco: Workers gain, land owners lose, nominally. 20 / 34

Does the wage go up more or less than 50%?

Suppose w increased by 50%. This would put it at point B.But the equilibrium is down and to the right compared to B.Therefore, wage goes up by less than 50%.In other words, w has increased because of the tariff; but w/pC hasfallen because of the tariff.

I This is the cloth intercept of the workers’ budget line (next slide).

Since pT is unchanged, w/pT has risen due to the tariff.I This is the tobacco intercept of the workers’ budget line (next slide).

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Budgetline workers

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Income of Northern capitalists

Recall thatrC = pCMPKC

(LC/K

).

We have pC ↑ by 50% and MPKC(LC/K

)↑, hence rC up by more

than 50%.Real capital income rCK/pC and rCK/pT also rises.

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Budgetline capitalists North

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Income of Southern landowners

Recall thatrT = pTMPKT

(LT/A

).

We have pT unchanged and MPKT(LT/A

)↓, hence rT↓.

Real capital income rTA/pC and rTA/pT also ↓.Budget line shifts in.

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Budgetline landowners South

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Summing up

Factors specific to the export sector are unambiguously hurt by thetariff.Factors specific to the import-competing sector unambiguously benefitfrom the tariff.Mobile factors (labor) could go either way.

I Doesn’t matter what a mobile worker does or where he/she is:I Effect of tariff will be the same.

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Case study IIAssume two sectors in Norway, potato and salmon farming.Comparative advantage in salmon.Ricardo-Viner model with two inputs, capital and labor.Capital is specific to the sector. Tariffs:

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Case study II

Analyze the impact of the tariff on...

Prices.Employment and output in the two sectors.Nominal wage and nominal capital income.Real wage and real capital income.

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A full trade model

Introduce a second country, Europe.I Europe similar to the US, except Europe is less productive in tobacco

growing:MPLTUS >MPLTEurope

Drop the small economy assumption −→ prices endogenous.

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The RS curve

As before, wages equals the marginal product of labor in each sector,so

pCMPLC(LC

K

)= pTMPLT

(LT

A

)pins down wages w , LC and LT in each country.This must mean that LC/LT is (an increasing) function of pC/pT .This must mean that QC/QT is (an increasing) function of pC/pT

−→ RS curve.

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The RS curve

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Autarky and trade

Autarky:I Europe RS curve to the right of US RS curve.I Identical RD curve −→ pC/pT lower in Europe.

Trade:I pC/pT must rise in Europe.I Supply>Demand −→ Exports of C from Europe.

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Aggregate welfare : Europe

A: Autarky production & consumption. Budget line (slope pC/pT ) istangent to PPF and indiff curve.B: Trade production. Consumption? 34 / 34